February 2014 Archive for Know Your Market

Whether milk prices rise or fall, the Livestock Gross Margin for Dairy program is a good choice for managing risk. Here’s why.

By Ron Mortensen, Dairy Gross Margin, LLC

Managing risk involves answering questions regarding a dairy’s financial situation. What is your break-even? What do your cash flow projections look like? What milk price does it take to meet your objectives?

These questions are a little different than market-oriented topics. That is another can of worms. Are milk prices in an uptrend? Is demand growing or shrinking? Are there new highs in milk prices (or new lows in feed prices) that should be considered in a marketing plan?

In answering both the financial and market questions, we have always talked about blending marketing tools to reduce risk for your dairy operation. For example, the blend could be up to 33% in forward contracts, 33% in USDA’s Livestock Gross Margin for Dairy program (LGM-Dairy) or put options and 33% open. The reason for the mix: If prices go higher, you only have 33% sold. If prices go lower, you have 66% covered with LGM-Dairy (or put options) and futures. Blending provides the opportunity for managing financial risk, while still benefitting from strong prices if they occur.

LGM-Dairy and options strategies have worked great for the past few months. You may have paid a small premium. But the market moved significantly higher, giving you a big cash flow boost over the minimum price protection from the LGM product.

The last few months were a big win for those of you who set up the marketing strategies with something open on the top. Why is this important? Because everyone needs to earn back some of the losses for the past tough years and/or build cash reserves for the future.

A picture seems to say it all. Margins are good from a historical perspective. How long they last is still an issue. This chart does tell us, once we get to the high end, that margins do move lower. Selling into a big discount or lower prices can be hard. The advantage of using LGM or options is that, if the milk futures markets do move higher, you do not get trapped. If markets do move lower, you have coverage.

The big question: What if I could take these margins and have a minimum guarantee? Would it give me good cash flow?

A final thought: It can be hard to sell into a discounted futures market. This is the situation right now, with milk prices lower almost every month for the next 10 months. The discounts can turn out to be correct, and cash milk prices can go lower. However, prices can climb higher if strong demand continues. LGM-Dairy or options are a great choice. If prices go lower, you have coverage. If prices move higher, you can capture the gains.

Ron Mortensen is principal of Dairy Gross Margin, LLC, an agency that specializes in LGM-Dairy products, and owner of Advantage Agricultural Strategies, Ltd., a commodity trading advisor. Contact him at ron@dairygrossmargin.com or visit www.dairygrossmargin.com.